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March 28, 2023
By Nicholas P. Flint

It’s 2023 and most M&A professionals are using words like “uncertainty” and “pessimistic” when it comes to the outlook for M&A activity. According to the Association for Corporate Growth (ACG), nearly 70% of the middle-market deal community believes there will be the same or lower deal activity this year than last. With a recession looming and interest rates remaining at high levels, a slowdown of middle-market and upper-middle market M&A activity is inevitable. But what about the smaller, lower-middle market or Main Street deals?

The year 2021 and the first half of 2022 saw record-breaking M&A activity, high-flying EBITDA multiples across most industries, and even what some buyers might call “reckless” acquisitions—buying companies whose financials don’t quite support the price tag. With all the excess cash dumped into circulation by the U.S. government, nobody should be surprised. But now the tides are turning, and the predictable result of the government’s own reckless fiscal policies has led to historically high inflation, and now an economic recession.

Buyers in middle-market deals (i.e. transactions with purchase prices between $25 and $500 million) now face a trifecta of issues: (1) higher interest rates that make the cost of debt too high for acquisitions; (2) a negative and uncertain economic outlook of prospective targets and of the buyers’ own business model; and (3) sellers who still think their companies should sell at last year’s multiples and therefore at last year’s higher prices. This has and will continue to bring about a slowdown of activity for deals in this price range, a class of M&A activity typically driven by private equity firms.

But the “smaller” deals (i.e. less than $25 million) seem to be continuing full steam ahead, notwithstanding the uncertainty in the rest of the M&A community and especially in the private equity world. The reason is likely that these transactions are typically driven by “strategic” buyers—players already in an industry who acquire companies to eliminate competitors or increase synergies, rather than to roll up businesses at scale as a PE firm might. Strategic buyers typically do not rely as much on debt financing for their deals (and even if they did, the cost to borrow is dramatically less due to the dollar amount involved), and are inherently more comfortable with the target businesses they are acquiring because of their knowledge of the industry and of the target as a competitor.

None of this is to say that the fallout of a recession and the slowdown in middle-market deal activity will not trickle down to the lower-middle class of M&A transactions. Buyers and sellers can still expect lower EBITDA multiples and resulting deal values, longer periods of due diligence for buyers to get comfortable with target businesses, and perhaps even creative deal- structuring with concepts such as seller-financing. Of course, deal parties must still engage sophisticated counsel to navigate these issues, but at least the smaller deals seem to remain active—for now.

Nicholas Flint is an associate attorney with Flint, Connolly & Walker, LLP who represents domestic and international clients on a variety of corporate and transactional matters, including mergers and acquisitions, joint ventures, private equity and venture capital transactions, financing and lending arrangements, and debt and equity offerings. Mr. Flint routinely works with accounting professionals and M&A consultants and advisors in connection with his transactional work. In addition, Mr. Flint serves as a general business and legal advisor to his clients, counseling on matters such as corporate governance, executive compensation, regulatory compliance, and commercial contracts.